Ever wondered how and where your crypto is stored? There are many different types of crypto wallets that token holders can use to store crypto. But, they can generally be split into two broad categories of custodial services: custodial and non-custodial wallets.
Both custodial and non-custodial wallets have their pros and cons. Let's explore custodial services meaning and their differences so you can learn when to use one type or the other.
What Is A Cryptocurrency Wallet?
A crypto wallet is a tool that allows you to interact with a blockchain network. Among other things, you can use it to send and receive cryptocurrencies or access decentralized applications (DApps). It is made up of two main components – a public key and a private key.
If people want to send you crypto, they can make a transaction to one of your addresses, generated by your wallet's public key. Your wallet addresses and your public key can be shared with others (hence the term public). Your private key, however, should be treated as a confidential password because it signs transactions and provides access to your funds. As long as you keep your private key safe, you will be able to access your crypto from any device.
While cryptocurrencies are digital, crypto wallets that hold private and public keys can come in various options – the keys can be printed on a piece of paper, accessed via desktop wallet software, or stored offline in hardware wallet devices. But regardless of the wallet type, you will always have either a custodial or a non-custodial crypto wallet depending on your preferred custodial service.
Custodial Services Meaning
Simply put, crypto custody means securing the private key that proves you own of the funds held within your crypto wallet. In traditional banking, all custodians are financial institutions, as required by law. With crypto, however, holders have the opportunity to be their own custodians or trust a third-party that offers custodial services to be their custodian.
Using gold bars as an analogy, you can either store them under your bed to keep them safe yourself or pay a third-party custodian to lock them in a vault protected by security guards. With that in mind, there are two main types of crypto custody for you to know.
Self-custody
As discussed, self-custody is when you personally hold the private key for your own wallet. This means you are the only one who can prove ownership of your funds and access your holdings. With great power, however, comes great responsibility. Being your own custodian means having complete control over your wallet, but it also means you bear all the risks too. If you lose access to your physical device (cold wallet) or forget the private key, your crypto will most likely be gone forever.
Third-party custody
Those who do not want to take the responsibility of managing their own accounts or find it too intimidating to deal with the tech might want to turn to a third-party custodial services provider. These are registered, regulated financial institutions that have acquired a state-level or national license to act as a custodian.
This type of crypto custodian holds clients’ private keys to their wallets in a safe manner and ensures the security of their holdings. From the user's point of view, it is similar to having a checking account with a bank. When you register to open an account, you must undergo know-your-customer and anti-money laundering checks. When you store crypto with a third-party custodian, you’ll be expected to complete the same sort of checks to make sure your cryptocurrency was not acquired through illegal means.
There are three different kinds of third-party crypto custodians based on the financial institutions:
Exchanges
All centralized cryptocurrency exchanges take care of their customers’ crypto custody. Some crypto exchanges and platforms outsource their security needs to an external custody provider that safeguards the assets under management. In any case, it’s worth knowing that when you set up an account and hold assets on a centralized exchange, you do not hold the private keys to your exchange wallet. This exposes you to potential losses if the exchange is hacked or disappears with users’ funds.
Digital asset managers
As cryptocurrencies have matured as their own asset class there has been an emergence of digital asset managers that act like banks for crypto holders. These institutions, like banks, are regulated and licensed to offer crypto custody. Most notable native crypto custodians include Anchorage, NYDIG and Paxos.
Custodial banks
Starting in July 2020, every custodial bank in the U.S. can custody cryptocurrencies, too, after the Office of the Comptroller of the Currency (OCC) cleared the way for all nationally chartered banks to provide crypto custody services. This opened the door for custody giants such as BNY Mellon, Citibank and Fidelity to enter the crypto custody market.
Note that some of the third-party custody providers (Fidelity, BitGo, Bakkt) are only available for institutional investors. Others may require a minimum balance so high that it excludes most everyday holders from accessing their services. For example, Coinbase’s dedicated crypto custody service, Coinbase Trust, requires a whopping minimum balance of $500,000 in digital assets to qualify for its custody system.
Don’t fret if you don’t have that sort of money invested in cryptocurrency. Some custody providers have made their services available for retail clients, too. A few examples include:
- Blockchain.com
- Casa
- Gemini
- Nuri (formerly Bitwalla)
- Costs Of Custodial Services
As with any type of service, providers typically charge a number of fees for safekeeping your money, just as regular banks do when you have a checking or savings account. Moving crypto in and out of your account also can incur fees. These costs usually fall into one of the following three categories.
Custody fee: Custodians ask for a certain percentage point based on the value of the assets under custody every year. This is usually less than 1%.
Setup fee: a flat rate for opening a custodial account. It’s worth noting some crypto custodians waive the fee and let users open an account for free.
Withdrawal fee: You might pay a fee every time you take crypto out of your account. This can be a flat rate or a percentage point of the value you withdraw.
As an example, U.S.-based Gemini has a 0.4% annual custody fee. The company waives the setup fee so you don’t have to pay to open an account but any withdrawal from the account costs $125, which is deducted from the crypto asset you withdraw.
If you choose to go with self-custody, you save on the custody, setup and withdrawal fees, but do not expect it to be free. The user has to take care of the wallet and buy a storage product to keep the private key safe.
Pros And Cons Of Custodial Wallets
As discussed, the major downside of custodial wallets is that you have to trust your funds and private keys to a third party. In most cases, these custodial service providers will also require identity verification (KYC). The advantage, however, is the peace of mind and convenience. You won't have to worry about losing your private key and you can contact customer support when you run into trouble.
When using custodial services, make sure you choose a reliable company that offers high security and insurance coverage. Look out for custodians that are regulated and compliant.
Closing thoughts
Custodial wallet or non-custodial wallet? Most crypto users use both, but it all depends on your needs and having learnt custodial services meaning would surely aid in your decision-making process.
If you like having full control over your assets, or simply want to use blockchain technology to interact with DeFi applications, you should consider a non-custodial wallet. However, if you are looking for a service provider that can take care of your storage needs while you trade or invest, you can look for reliable custodial wallet service providers.
Bear in mind that whETHer you are using a custodial or non-custodial wallet, you should always be careful and adopt best practices to enhance the security of your funds.
